ETF Focus

The Attraction of Opposites

When traders move money out of certain bearish ETF funds, it's frequently a bad sign for the stock market. Conversely, as long as investors continue to pour money into these bearish bets, stocks tend to do relatively well. Also, a new, low-volatility fund and its quirks.

The traders pulsing in and out of these oft-criticized products are usually thought to be too rapid-fire, or their strategies too indecipherable, to offer much information about where stocks are heading next. But it turns out that this view may be wrong, at least as far as some of the niche's asset flows are concerned.

Tuning a stock portfolio to when bearish assets flee appears to work well in at least some cases. A possible strategy: A $100 investment in the
SPDR S&P 500 ETFspy 0.6040417499444815%SPDR S&P 500 ETF TrustU.S.: NYSE Arca226.51
1.360.6040417499444815%
/Date(1481335200001-0600)/
Volume (Delayed 15m)
:
76711384AFTER HOURS226.65
0.140.061807425720718734%
Volume (Delayed 15m)
:
11294382
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
1.9108525009933337% Rev. per Employee
N/AMore quote details and news »spyinYour ValueYour ChangeShort position
(SPY) at the start of '07 that's been switched to a short position each time bearish fund flows suffer a negative five-day moving average would have turned into more than $145 as of mid-March (excluding transaction costs), according to TrimTabs. That compares with roughly $110 (including reinvested dividends) for the S&P 500 fund's total return over the same period. Last year's trend kept largely to pattern.

Money flows into bearish ETFs weakened somewhat in the middle of last year, and then took a dip as stocks started tumbling in July. They weakened again as stocks' rebound petered out in November.

There are a few theories as to why more bearish bets may be a good sign for stocks. One is that many traders who buy these products are generally bullish and use them as short-term hedges—positions they'll no longer need if they're planning to sidestep a plunging stock market.

"The users of these leveraged funds are usually more sophisticated investors," says TrimTabs' vice president, Minyi Chen. "When somebody is shorting the market, they're often hedging their long positions or using it as a risk-control component."

But another factor may be the little guy. Leveraged and inverse ETFs are popular with the retail, or individual, investor, whose behavior is already high up on the short list of contrarian indicators. It may simply be that much of the flow in and out of these bearish funds reflects the actions of the least patient and most caffeinated traders.

Individual investors may even have been the majority of owners of the assets in two-times inverse, three-times inverse, and twice-leveraged ETFs as of the end of last year, as per a recent Deutsche Bank guesstimate of federal 13-F filings. The figure for the highest-octane products, three-times leveraged ETFs, was as high as 91%. (These figures could be way off the mark. There are no good data on the subject, since many institutional investors don't have to make the same portfolio disclosures as larger ones. A healthy dose of retail-investor participation fits with brokers' and strategists' anecdotes about which market participants tend to use the products, however.)

It may well be that both factors are working together to create a relatively robust investor-sentiment signal. Either way, it's clear that leveraged and inverse funds have an unsung virtue. "It's not too dissimilar from the put-call ratio or short-interest ratio. It seems to be relatively the same concept," says Knight Capital Group managing director Eric Lichtenstein.

That's been enticing for investors seeking shelter from market swings like last August's; they've plunked $1.6 billion into the fund over about 10 months, and they've kept pouring in this year, even though the fund is up only 1.5% year to date.

However, screening for staid, stable stocks can bring its own quirks. Anthony A. Renshaw of risk-modeling firm Axioma unpacked the fund's holdings to discover a few predictable issues—and a few that were surprising.

Unsurprisingly, the fund has a heavy bias toward the consumer staples and utilities sectors, which together make up more than half of the ETF as of this month. That means that investors are making sector bets by buying into this fund, whether they realize it or not.

But the fund also lacks a number of the S&P 500's very large companies like
Chevroncvx 0.5557002691673179%Chevron Corp.U.S.: NYSEUSD115.81
0.640.5557002691673179%
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:
5728292AFTER HOURSUSD115.81
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217414357222.103
Dividend Yield
3.730247819704689% Rev. per Employee
1760670More quote details and news »cvxinYour ValueYour ChangeShort position
(CVX), effectively giving it a bias against massive companies. It also has what Renshaw says is a healthier-than-expected dose of companies that prefer a strong U.S. dollar.

The larger issue may be that investors who seek out low-volatility stocks are at risk of lumping together companies whose shares aren't budging lately for a range of very different reasons, not all of which are permanent.

For instance, while some companies' stocks may always be shelters in a storm, others may simply have withstood 2011's market downdraft for idiosyncratic reasons that won't be repeated, like banner earnings or buybacks.

Mathematical screens for low volatility in any relatively short period tend to lump together companies whose shares didn't budge much for quite different reasons.

Axioma's own aim in publishing the study is to push "purified factor ETFs" that strive to control for such issues. But it should be clear even to investors who've never considered the matter that there's likely no magic ETF recipe for ridding their portfolios of market volatility.